Some years ago, I was involved with a group of companies that was taken over by a large public group. The new owners came to see what they had bought with their tails wagging like dogs with a new bone. Within two years an industrial dispute had brought the business to its knees. Tails, once wagging, were now between their legs.
Due diligence, had it taken place, would have informed them of the activities in the group they were acquiring and alerted them to the risks they were taking on.
The purpose of due diligence is to provide information to enable one party to make an informed judgement on the balance of risks and opportunities in a merger.
Unlike an audit, there is little or no regulatory guidance as to what should be covered in due diligence. The scope will vary considerably from case to case.
In the social housing sector, it may be thought that only limited due diligence is required because no money changes hands. I think that is wrong.
The assumption of business risks, and often unquantified liabilities, could prove very costly in the long run, regardless of whether money is paid up front or not. The principle of 'buyer beware' applies to social housing just as much as elsewhere.
The scope of the review should always be agreed with the investigating accountant before work begins. There is little point in asking your advisor to analyse the past by summarising, for example, the financial performance and balance sheets for the previous three years.
This information is publicly available and the purchaser can do this much more cost effectively. It is far more important to focus on those things that are not obvious from published financial information.
The key document is the business plan. Stock transfer organisations will have needed a validated business plan to obtain initial funding and Housing Corporation registration.
These plans are nearly always updated year on year, but they are seldom independently validated again. Traditional housing associations may have relatively poor business plans, and seldom ones that cover a 30-year period.
Knowing whether a business plan exists, whether it is arithmetically correct, whether it is based on the assumptions that are in the corporate plan, and whether those assumptions are reasonable and are essential information for the 'purchaser'.
One area that is rarely considered properly is an assessment of the quality of the senior management team and of the board
In the course of this work, questions will be asked about the state of the stock condition. Has an up to date survey been carried out, and if so has it been properly evaluated and correctly included in the business plan?
The liability for backlog repairs and improvement of estates is not something that can be picked up from a review of the audited financial statements.
However, it is one of the biggest financial risk areas and certainly one that the 'buyer' needs to get a handle on before deciding whether to go ahead.
The rent plan needs to be understood and the methodology reviewed and checked. Has the rent plan been correctly included in the business plan? What effect has this had on peak debt, repayment periods and covenant compliance? Have the funders been kept in the picture?
It is also important to know whether there has been proper compliance with statutory and regulatory requirements.
Corporation and value added taxes are potentially risky and costly areas and need to be carefully reviewed. Similarly, the concerns of the corporation and internal and external auditors need to be understood and evaluated. Their reports should give comfort regarding the strength of the key controls, the systems and the reliability of the financial information.
One area that is rarely considered properly is an assessment of the quality of the senior management team and of the board. This is particularly important if the target RSL is to have autonomy within the new group structure. An assessment of the quality of people is often seen as 'too difficult' and then ignored.
Some comfort can be obtained from a review of the teams' past performance.
But if the target RSL is seeking a merger because of its inability to cope with rent restructuring, or to deal with its repair liabilities, for example, this must raise questions about the quality of its management and governance.
Although a difficult issue, it is one which should be tackled. Senior management are not recruited these days without using a range of assessment tools. Why should the acquisition of people through merger be treated any differently?
Source
Housing Today
Postscript
Bill Dascombe is a partner with RSM Robson Rhodes.
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